We forgot to mention last week that we’ve switched up the look and design of the newsletter to hopefully make it a more seamless reading experience. So please don’t be alarmed, we’re the same, just better.
Now enjoy our charts...
Stores of Value
Yes - dates, price levels, and legends have purposefully been removed for this exercise.
One of these charts is widely considered the world’s current ‘store of value’ . The other is attempting to become a ‘store of value’ for the future.
One of these assets saw a greater than 50% decline in value in the early days. So did the other one.
In more recent times, one of them saw a greater than 40% pullback, before stabilizing at a low, then rallying back to all-time highs. The other saw a 50% pullback, has stabilized, has momentous tailwinds, and is yet to be seen if new all-time highs are coming.
Can you guess what charts these are?
CAPEX to Profits
Capital Expenditures is the least appreciated metric in finance. Hard stop.
Why? Because it’s the most meaningful metric which provides relevant insight into the long-term future growth prospects of a company. It’s not the ONLY metric that matters, but for most companies, it’s the most relevant for future growth (R&D, below, for certain industries like Tech and Pharma is equally important).
Market wide CAPEX tells a story of far less reinvestment for the future since about the mid-80s. What happened in the mid-80s? Most would generally agree that this time saw peak globalization, paralleled with the beginning of the Reagan/Thatcher administration’s policies of deregulation and privatization. A time when the US (and most of the world) fully embraced outsourcing most of their operations that were not deemed mission critical (even if they were, in fact, mission critical).
Ideally, as COGS and OPEX decline, subsequently driving profits up, that excess cash would be reinvested into projects, infrastructure, or R&D, all being additive to top line growth and margin expansion.
So, did the gift of excess cash go somewhere other than CAPEX that is almost as productive?
R&D to Profits
Well, it didn’t go to R&D, that’s for sure.
Similar to CAPEX, R&D is a crucially important number for long-term corporate performance. And similar to the CAPEX chart, we see this number declining since peak globalization and deregulation as well. (Ignore the spikes in the early ‘00s, ’08 and ’20, as those are periods where earnings cratered during the dot-com bust, the GFC, and the Pandemic.)
So, what the hell happened to all that extra free cash flow?
Well, I’ll tell you where almost $6 trillion of it went since 2000. To the shareholder class of publicly traded companies.
Welcome to Financial Engineering 101. This miraculous feat of corporate tomfoolery is where companies place less emphasis on the fundamentals of their business, like profitability and free cash flow, and instead ‘engineer’ their financial statements to mechanically create more ‘value’. The primary means of this artificial value creation appears when companies buyback their own shares to reduce the number of shares outstanding (the denominator in EPS), which drives EPS up without any incremental earnings (Wall Street analysts then announce that the company beat earnings forecast = stock price up). Additionally, by reducing the amount of expensive equity capital in their capital structure (equity is more expensive for firms because they are giving away ownership), their Weighted Average Cost of Capital (WACC) goes down, which mechanically drives the Discounted Cash Flow (DCF) valuation of a company up. Now, in a truly free market the relationship between equity and debt wouldn’t be this simple, because the more debt in a company’s capital structure, the more bankruptcy risks the firm takes on, causing both debt and equity holders to require a higher rate of return from the company. But since the Fed has essentially eliminated bankruptcy risk, firms are free to stock up on as much debt as they can get their hands on, without their cost of capital increasing. Better yet, it continues to decrease! More debt = lower cost of capital = higher valuation. Welcome to America people.
These topics will be explored further in future Editorials, but for now, it’s clear that share repurchases utilizing 1) excess cash flows from decades of reduced expenses via globalization and deregulation and 2) cheap debt via Zero Interest Rate Policy (ZIRP) have both contributed heavily to outsized stock price valuations (do you honestly believe Facebook is a trillion dollars company?).
Labor Participation Rate
This one is no Bueno (I’m currently in Mexico and working on my Spanglish).
What’s interesting about the Labor Participation Rate is that we expected in 2011 to see participation amongst boomers decline as they began to retire, and we saw that, but only for a couple of years. Then, after leveling out around 2013, it actually began to increase once again.
Now, this could have been due to more 25–52 years-old entering the workforce, but given the sheer size of the boomer population, we should’ve still seen their exits outweigh the incoming freshman class of workers.
Either way, we saw participation start to climb again until the Pandemic, but we’ve yet to come close to recovering.
As an anecdotal aside (I usually hate anecdotes as they’re typically misleading), I’ll tell it anyway and let you decide if it matters. Being in Mexico and meeting many Americans down here, I’d say 90% of them are ‘not even thinking about looking for a job’ and are currently collecting unemployment. Do with that what you will.
Nuclear energy, and our avoidance of it for no rational reason (please don’t start with the Chernobyl or Fukushima comments), is possibly one of the biggest missteps in modern history.
The amount of power that is created with miniscule amounts of negative discharge (nuclear waste) is mind boggling.
This illustration was brought to our attention by our friend Carlo Spingardi who writes a newsletter called The Green New Spiel. If you’re interested in the Green Economy, give it a read.
This was brought to our attention by our buddy Tyler Neville over at Blockworks who writes an outstanding daily newsletter. We’ll just borrow his words:
“Tiger is now outpacing SoftBank on PE growth investments. Either Chase Coleman is smoking the same stuff as Masayoshi Son or he sees something that everyone else is missing.”
That's it for this month.
If you didn't catch last weeks Markets Update, "Tapering, The Return of Growth, and Oil's 7-Years High" go have at it.